Podcasts Liquid Assets: Investing in the world's most essential resource

Damian Cilmi, Praemium Head of Investment Managers and Governance: 0:06

Welcome, listeners to another episode of the Praemium Investment Leaders Podcast. I'm your host, Damien Cilmi, Head of Investment Managers and Governance at Praemium, one of Australia's leading investment platforms. Today we bring you another exciting podcast where we head into the world of water. I was telling my 11-year-old son about the podcast this morning. He asked me how do you invest in water? Well, we're here to tell you all about it. There'll be plenty of puns about liquidity some avoidable and some not, but we're really pleased to bring this topic to our listeners because many will be not aware of how this market works and how investors are utilising it within their portfolios.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 0:45

About our guest today we're pleased to be joined by a real industry expert in this field, Euan Friday, who is Chair and CIO of Kilter Water. Prior to joining Kilter Water in 2008, Euan spent 10 years at PwC and CFO at STA Travel At Kilter Rural. Ewan has been integral to the establishment of the water business, which today manages assets across all major classes of water entitlement. On the issue of Southern Murray-Darling Basin and about Kilter Rural, the firm was established in 2004 to deliver profit with impact, investing at scale in the regeneration of farmland, water and environmental protection. The firm has won numerous awards, and notably the 2023 AFR Sustainability Award in the Environment and Agricultural category. Kilter manages investment funds across agriculture and dedicated water rights strategies and manage in excess of $300 million. Euan, welcome to the show.

Euan Friday, CIO, Kilter Rural: 1:49

Thanks, Damien, great to be here and I can assure you there's going to be plenty of water puns.

It's pretty hard to avoid. I know they crop up all the time.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 1:54

Yes, I'm sure they will. We try and bring new and novel investment ideas to people. And again, water rights. I imagine you're out there trying to explain to people. You know how they can invest in it, but let's kind of get to the top of the capital markets. How that operates for these securities, but what's the origins of the tradable water right market?

Euan Friday, CIO, Kilter Rural: 2:23

Yeah, that's a great question, and whilst it does seem sort of novel and new, it's something we've been doing for institutional and wholesale investors since 2008. So, you know, we have been at it for a while, but that was really about as early as you could invest in water entitlements in the way that we invest The origins of them is that they came about sort of through an economic development program, mostly post-war, where the government spent taxpayer dollars and built large dams in the Great Dividing Range and then built irrigation districts which enabled water to be delivered to farms, and in exchange for farmers developing their farms to plant orchards or irrigation bays to grow crops, they got given water entitlements that were based on the water that was being captured in those dams and that worked fine for many decades. But it certainly became apparent during the 70s and 80s that they had also originated some problems, particularly environmental problems with water overuse. It was causing things like salinity Plus they realised they'd licensed the extraction of too much water and they started a process in the early 90s called the National Water Initiative to try and deal with that, and one of the first things they did it in 1993, was to cap the volume of water that could be extracted from these systems. And that volume of water entitlement that was n issue with farmers was capped at that level. So they

Euan Friday, CIO, Kilter Rural: 3:50

And then they set about a process to free up those assets and make them tradable.

Euan Friday, CIO, Kilter Rural: 3:57

Originally, when they gave them to farmers, they were embedded in their land titles. So if you sold a farm in the Goulburn Valley that had a water right, that was on your land title. And that process culminated on the 1st of July 2007 through what they call unbundling, and those farmers then had two assets, so they had a water entitlement and they had a land title. And that water entitlement has all the same features as a land title in that it's mortgageable, it's transferable, it's enforceable, you can lease it and it's managed in the same place as the land titles and the land titles office as a Victorian Water Register, and the same thing in New South Wales and South Australia. So you end up with these assets and our history in this space was that we were buying and aggregating farms in irrigation districts which came with water entitlements, and we could start to see this opportunity to invest directly in water.

Euan Friday, CIO, Kilter Rural: 4:52

This was in 2008. And we pitched that to our institutional investor at the time and said, hey, why don't we invest directly in these water entitlements, build out a portfolio of them and create water products for farmers that they didn't have previously? So that's sort of the origins of how it came about.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 5:10

And was Australia the first to have this kind of tradable market, or were there any other examples around the world that they could lean on?

Euan Friday, CIO, Kilter Rural: 5:18

I think it's the first to have a tradable market in this form. Certainly, there are water assets or tradable rights in other parts of the world, notably the US, but the way their structure is quite sort of arcane and it's really challenging to manage the transfer of them. They don't have the same kind of. The thing that makes it work so efficiently here is that they're fungible. So, for example, a Goulburn water entitlement or a Vic Murray water entitlement, every unit of those you know thousands of megalitres that are on issue is the same, and so that means that they can be split and amalgamated, they can be traded, whereas my understanding of the water rights, say, for example, in California, they're sort of like a first-in, first-served right on the river or the system, and so each right is different and therefore there's big challenges in transferring them to other people. So, yeah, that's my understanding that certainly to have a market like we do in Australia is really rare and there's certainly nothing like it that has the capacity to invest in an asset that is tradable over such a broad geographic region.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 6:31

It's funny. We have spoken to some other portfolio managers about royalties in other countries as well, and the registry and the transferable nature is a very important part of what makes a market. So it seems like Australia's got a very as it relates to these rights anyway, so it's good. But let's delve down into the actual entitlements themselves. You know what does the entitlement look like and what can the owners do with that entitlement.

Euan Friday, CIO, Kilter Rural: 7:01

Well, I think it's really important to understand what the entitlement gives you. So the entitlement is a right to share in the water resources in a defined system. Sure, and the defined system is based around storage. So if I was to be talking about, you know, like I was a moment ago about a Goulburn water entitlement, it's based on the water that gets captured in the Eildon Reservoir and all of the Victorian high reliability Goulburn water entitlements are the same. So that water entitlement enables you to get what's called a water allocation each year, and the water year commences on the 1st of July and finishes on 30 June, just like our financial year. And on the 1st and the 15th of the month each month, from the 1st of July, the Water Authority makes an allocation announcement up to 100%  So at the moment, you know we've got a lot of water in storage and so we're sort of sitting at allocations, north of 70%, and as the year progresses, 1st and the 15th, they make another allocation announcement and that will progress up to this year because there's so much water in storage. 100%, yeah, Now.

Euan Friday, CIO, Kilter Rural: 8:10

So the owner of that entitlement's getting his allocations. Those allocations are going into what's an allocation bank account, much the same as a bank account. You can go online, look at your statement. As the Water Authority makes those announcements, you get credited. So if you're 100 megalitres, it's your account. You have 100 megalitres of entitlement, and had a 50% allocation on the 1st of July. You've got a credit of 50 megalitres. So if you're the farmer and you want to use that water to irrigate your field, then you contact your local Water Authority online.

Euan Friday, CIO, Kilter Rural: 8:49

to you and it comes through the infrastructure. It's amazing infrastructure. Not many people appreciate how sophisticated it is, but yeah, it basically delivers that water in a slug through the channel network, it goes out on your farm, it gets metered and your water account gets debited. And so that's from the farmer's perspective. Or the farmer might find themselves in a situation where they've got surplus water. You know they had 100 megalitres. They only used 50 for the year, so they've got 50 surplus. Then they can just go online and trade it to somebody. And there's many water marketing intermediaries and they run online platforms so you can see, buy, sell spreads there and they can put their water up for sale.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 9:31

Somebody could match that, buy it and it'll be transferred to them and I suppose over that year as well, that they would have a fair idea of how much they're going to, and that allows them to do other secondary transactions, as you talked about as well.

Euan Friday, CIO, Kilter Rural: 9:47

Yeah, absolutely, although that's why it's such an interesting space,  because really its applied microeconomics 101 in action. You can see each year exactly what's going on in terms of supply and demand. But, unlike most other markets, it doesn't sort of work towards equilibrium because the supply side is determined by the weather, as is the demand side. So you find yourself in a wet year, like has been the case for the last four years, where there's a lot of water around, so the dams are full, there's a lot of supply, the farmers don't need much water.

So they have less demand, whereas when it's dry, there tends not to be so much water in the dams and the farmers need more water because they're not getting the rain. But you know, being able, you can certainly plot exactly what's going on, as to why you see these allocation price movements, and allocation price itself is quite volatile for exactly those reasons.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 10:51

Yeah, and obviously we talked about farmers, so they're very central to all of this. But let's talk about some of the other market participants as well, as we kind of build out how this market works. So who's operating the market and what are their motivations? Some of the other participants in here yeah, so who's operating the market and what are their motivations? Some of the other participants in here.

Euan Friday, CIO, Kilter Rural: 11:14

There's farmers, and they're by far and away the largest group of participants in the market. There's people like ourselves, investors in the market, and then there's the government's participation in the market has been through the Murray-Darling Basin Plan and it's been, you know, an explicit participation in the market to recover water for environmental purposes.

Euan Friday, CIO, Kilter Rural: 11:38

So if you sort of looked at the volume of water entitlement or the value of water entitlement on issue this is in the Southern Murray-Darling Basin it's split around about 25% owned by the government, maybe another 10% to 15% owned by investors, and then the largest chunk is the farmers. It's sort of 60%. One of the major sort of driving forces in the market that we see over the next year or two is the government, because there's been a renewed commitment from this current federal government to see the basin plan delivered in full, and so just recently they have announced a tender process to recover water from, consumptive users, farmers and the like, to go towards meeting basin plan recovery targets. So it's the big news in water markets at the moment.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 12:38

Fair enough, and so you've talked a lot about the Murray-Darling basin.

Are there other markets as well, too? And, I suppose, what's the significance of the Murray-Darling in terms of the agricultural landscape here in Australia?

Euan Friday, CIO, Kilter Rural: 12:53

Yeah, I mean that's a big question and a great question. So look, if you think about the total value of water entitlements on issue in Australia groundwater, surface water, regulated, regulated, unregulated you know it's quite difficult to, you know get a handle on that number because a lot of these water rights aren't traded that often. But you're probably talking about a figure north of 50 billion dollars worth of water assets on issue in the southern basin. The figure is over 30 billion. So you can see that it's more than half well, it's really more than half and of that 30 billion, about 23 billion is owned privately for consumptive use.

Euan Friday, CIO, Kilter Rural: 13:34

So the significance of you know the southern basin is that you know it's by far and away the largest irrigation district and because of the way the system works and the interconnectivity of the three river systems the Goulburn in the south, the Murray in the middle, the Murrumbidgee in the north that enables this trade of water over a huge area roughly the size of Germany. It's by far and away the biggest market, but it's not the only market. I mean there's a number of other dams, there's water delivery in Tassie, there's, you know the Burdekin, there's the Burnett. You know, up in Emerald there are other dams, but what they don't have is this large diversification of industries and geographic area over which the water can be delivered and service a range of different irrigation water users.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 14:28

And so does that. You know, I suppose infrastructure certainty make it a very special and ideal place for farmers to go in and operate, to have that kind of certainty.

Euan Friday, CIO, Kilter Rural: 14:40

Yeah, well, I think there's a lot of things going on that make it,. As you know, really favourable for irrigated agriculture. Across the southern Murray-Darling Basin you've got a number of key irrigation districts, from down in South Australia, the Riverland, which has historically been a big grower of wine grapes, but also a lot of other perennial horticulture, into the Sunraysia, where you've seen a massive expansion in things like almonds up into the Murrumbidgee. You know it's really a massive food bowl. There's all sorts of different crops growing up there and increasingly these days you're seeing cotton being grown at significant scale in the Murrumbidgee, right through the Murray and down in the Golden Valley. So you have this huge diversification because you're getting different climatic factors. You know big pockets of fantastic soils, reliable water delivery. So it really is, you Australia's food bowl. There's no doubt about it.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 15:36

That's interesting and so just kind of taking a different tact on this, like getting into the, I suppose, the investment elements of a pricing et cetera. So kind of putting weather variations aside, what are the long-term trends that are driving, you know, pricing in this market and interest in this space?

Euan Friday, CIO, Kilter Rural: 15:59

Well, you know, as I said before, it really is like applied microeconomics 101. So you've got your supply side drivers and you've got your demand side drivers. On the supply side, you know it's hard to think of any other asset class that you can invest in that has scarcity, like water. In Australia. You know we are living on the driest inhabited continent and the water entitlements that we're talking about investing in here, as I said right at the outset, you know, through the National Water Initiative the volume of them that's on issue was capped back in 1993. And if you think about it sort of physically, it's capped by the dams that are there. You could really only issue new entitlements if you captured more water no-transcript. So they're not going to go and build any more dams, so that's capped there. So if you sort of think about the scarcity, it would be a bit like saying, look, let's build a fence around Melbourne, let's continue having population growth, let's take 25% of the current land mass.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 17:04

Don't allow it to grow.

Euan Friday, CIO, Kilter Rural: 17:05

Yes, let's say 25% of the land mass and say, well, we're actually going to take all the commercial, the housing out of that and we're going to repurpose that back to the environment. And yet you know this economy is growing, so you can see what would happen to land prices.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 17:20

Yeah, through the roof. 

Euan Friday, CIO, Kilter Rural: 17:20

Well, that's exactly the scenario that you see with the water entitlement market. And on the demand side, because you've had the establishment of the market and the water's been freed from land titles, it's been able to move in geographic terms, and so it's migrated to places and crops where people can pay more, where the underlying driver of all this is the gross margin per megalitre of water used that a particular crop can generate. And so you're seeing water migrate to higher-value crops, and for that reason, you've seen this century since the start, since 2000, a 16-fold increase in the area planted to almonds, and we're also seeing an expanded footprint to olives.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 18:08

I'm allergic to nuts, so I've got no idea about this almonds thing. Who's in all these almonds? 

Euan Friday, CIO, Kilter Rural: 18:14

Yeah, well, it's interesting. It's been a lot of institutional capital coming to that space and the biggest area planted to almonds in the world is in California. In fact, they account for about 85% of global production.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 18:27

Is this all about almond milk?

Euan Friday, CIO, Kilter Rural: 18:28

Well, I think almonds go into a lot of things. I mean, I like almonds. I don't drink almond milk. But the Almond Industry Board in the US has done a fantastic job of basically getting almond meal into just about every processed food on the supermarket shelves in that part of the world. And you know, now you've got almond milk taking off and markets like India and China. It's sort of becoming more of a luxury item and as disposable income increases, people are wanting more of them. So the growth trajectory on the product looks really favourable. And I think that what people realised was that there's just not many places in the world where you can go and put in a greenfield almond investment like Australia. You know they sort of maxed out California. They've got real problems there in terms of water availability. There's not that many places, if you look at a globe, where you've got the right climatic conditions and places in the Mediterranean. Try and find 600 hectares that you can do an almond development in Spain or Tunisia or Turkey. It's challenging and so there was a significant influx, particularly over the last 14, 15 years, of institutional capital into the almond space.

And almonds are pretty heavy users of water. So an almond orchard goes from using sort of two to three meg of water per June hectare when you plant it, up to about 13 to 14 meg of maturity in six or seven years. So we can sort of see, you know, based on the maturity of the orchards that have gone in this increasing demand from them into the future over the next five to six years, and that's quite significant. So yeah, on the demand side, you've got this changing demand dynamic as o has migrated from what were lower value annual uses, things like growing rice. Yep, you know it was a massive user of water, 20 years ago, cotton as well.

So it's done more to displace things like rice, yeah, okay, and say irrigated cereals and so forth, and that's really sort of changed the way allocation pricing works, particularly when water's scarce in times of drought, because an annual cropper, they can make a decision. They can say well, look, it's dry. Allocation prices are high.

My gross margin per megalitre is $350 a megalitre. You know a megalitre that I can generate by growing, let's say I don't know irrigated wheat. Yeah, price at $350. Might. I to turn $500 of o into $350 of wheat. I'm just going to scale back my production or I'm not going to grow any. But when you're growing an almond orchard and the price is sitting at $600 a meg or getting to $1,000 a meg, as it did back in 2019, well, I don't have any choice because I've spent over $70,000 a hectare establishing my almond orchard. I can't afford not to water it. So they have completely different sort of pricing decisions because they're not sort of thinking in the short term they're thinking in the long run, protect their asset and, as you know, the percentage of the you know water in an average year that goes to perennial crops has moved. When we started in this space it was around 12%, 13%. So now we're getting over 40% in an average year and getting up towards 100% in a very dry year, like we had back in the millennium drought. So these guys, they've just got a whole different way of thinking and they accordingly, you know, when water's scarce, we, you know, we see it gets increasingly higher each year, each dry spell.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 22:19

It's quite fascinating and I think to the story I think in the Barossa about this land change as well too, where they're all cattle farmers, a lot of them, and they're all repurposed then for vineyards as well. It's higher value and it brings in different types of capital and then they have to get all the infrastructure and everything in place in order to do it. So that's very interesting. So we're talking a bit about variation in prices as well. So what's the kind of range of returns that you've seen in these water rides over different kind of climatic conditions?

Euan Friday, CIO, Kilter Rural: 22:56

Yeah, so you know we track a couple of things. So we've got our own index that we've basically been running since the 1st of July 2007. It works like any other sort of value-weighted index and, you know, since 2007, it's sort of sitting around 10% 11% Yep 2007,. It's sort of sitting around the 10% 11%. That's an income and capital movement across the Southern Murray-Darling Basin. Certainly you do get periods when returns have been negative, so that's certainly been the case. s s b s some

Euan Friday, CIO, Kilter Rural: 23:30

Over the last 12 months We've had a situation where we've had the four wettest years on record in some parts of the Southern Murray-Darling Basin through to, you know, june this year, seen very low allocation prices and there's also been some, you know, reasonably significant headwinds for some industry participants, notably the wine grape guys. So it's been it's just been very challenging for many wine grape producers and even though we've now had the tariffs lifted by China, that's probably not going to solve problems quickly. Over the sort of medium term we sort of expect to see there will be you're t the fortunes of that sector will be improved. But because of those reasons you know, we've seen some]f owners entitlement who are servicing things like wine grapes because it's sort of relatively liquid. No pun intended. They, you know, have been able to….

Damian Cilmi, Praemium Head of Investment Managers and Governance: 24:27

We told people it was going to happen. Yeah, it was going to happen.

Euan Friday, CIO, Kilter Rural: 24:30

So they've been of shave off a bit of entitlement it, their cash flow, and so that's what we've been the market Right, and that's been, you know, , you know softening values slightly, so sort of 3% to 4% down over the last 12 But I said earlier, you the by the federal government that they are starting back their water buyback program, you know we've already seen just in the last couple of weeks around at least a 5% movement in entitlement values Because it provides a floor, I'm assuming. Well, it provides a floor. I mean there's sort of two factors at work here.

Euan Friday, CIO, Kilter Rural: 25:10

biggest buyer in the market by far. Yeah know. So if you sort of look at the total value of turnover in the market last year it was about $400 million, sort of ranges between sort of $400 million, $600 million that's about the number the volume of water that the government needs to buy back is sort of four or five times the multiple of an annual turnover. That's huge. So I don't know whether they're going to be able to do that. It seems like it's a big challenge.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 25:39

Have they given themselves a

Euan Friday, CIO, Kilter Rural: 25:41

They have, so I should have mentioned that under the original terms of the basin plan that was legislated in 2012, they needed to meet their recovery targets by 30 June just gone 2024. Okay, so they didn't do that. So they passed legislation in November last year and that legislation enabled them to push that deadline out to 30 June 2027. But it also re-enabled them to step into the market and recover water through buybacks. The coalition had previously, back in 2015, capped the volume of water that could be recovered through buybacks and so the legislation that passed back in November removed that cap and, as a consequence, we've seen them step into the market now and initiate that process again. So we do expect that. You know well, you know it's obviously very difficult to predict politics, but we do expect that there'll be sort of ongoing participation, likely from the federal government, as they seek to meet those recovery targets over the period from now until 2027. So that's one way it'll affect the market.

Euan Friday, CIO, Kilter Rural: 26:45

The other is you've just moved the supply curve to the left, so at any level of demand there's less water around. So you know, abares just recently did where they were sort of suggesting that, you know, a 4% to 5% reduction in consumptive use would see a So increase so prices so but we're expecting to see quite a larger reduction in consumptive use than 40%, like if they meet the recovery targets. It's more like 10%, yeah, okay, you know. So you think about how you value a water entitlement. price sort of like your yield. So if you're sort of getting a 10% increase in your yield or 20% or 30% increase in your yield, then you sort of expect to see the same flow through to the asset.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 27:26

Yeah, correct, just like you would in real estate. put

Euan Friday, CIO, Kilter Rural: 27:28

Yeah. So that's, you know, a significant driver. But also, you know, the ongoing transition that I was sort of mentioning before to higher value crops is really that that's at the heart of what's going on in this space and that's why we, you know, continue to be, you know, really positive about the outlook for these assets because, it's just really strong fundamental economic forces at work here.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 27:55

Before we get into some of the portfolio elements of it, what's, I suppose, current spot price and what's the kind of range been over different climatic conditions, to give listeners a sense of what's going on?

Euan Friday, CIO, Kilter Rural: 28:11

Range, as I said before, because of the way allocation prices work, is really wide. So at the end of last water year, just back in June, we had prices down around $20 a megalitre because you had water that people were holding that they couldn't use. They couldn't carry it over to this year and they couldn't use it, so it was becoming worthless to them. So today prices are sitting around $120 a megalitre. They did open more strongly this year than we expected them to, so in the first few weeks of July water allocation prices were around $140 a megalitre.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 28:52

Was that due to like any weather forecasts? I think it had just been a bit drier than people had anticipated.

Euan Friday, CIO, Kilter Rural: 28:59

Yeah, and I mean, that's a fascinating thing about this space, you can look at what you think allocation prices will be based on, say, the supply. What's very difficult to anticipate is how people are going to perceive the future at any point in time. This time last year there was more water in the system, but the outlook was for it to get very dry. The Bureau of Meteorology was forecasting a severe El Nino, as were other global weather models, and so the market had this view that, wow, it's going to get dry, there's going to be greater scarcity, and so water prices climbed from about $80 right up to about $200 in September last year, and they started raining again, and so prices came down.

Euan Friday, CIO, Kilter Rural: 29:46

So, over the longer capital-efficient term, allocation prices have traded between a range of around $20 at the bottom up to around $1,000. And last time it reached around $1,000 was in 2019, and that was the last really dry period we had. The volume of water that was around in 2019 was a good you know, half to two thirds more than was around in 2009. So we haven't really had a very dry period for quite a long time, and we expect that when we do, we're going to see really high allocation prices, well over $1,000 a million.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 30:25

and those allocation prices, that's you holding that's the , I suppose, of that right there. So we've got it on the capital account, if you will. Now also, what are you doing on the income side? What's the other part of the return profile for investors?

Euan Friday, CIO, Kilter Rural: 30:44

Yeah, so that's a great question, Damien. I hadn't really got into the whole sort of investment approach. You know, as I said at the outset, when we pitched this to our Insto investor back in 2008, the idea was to sort of invest in a portfolio and then create water products for irrigators, and really that's been the investment strategy ever since then. It's just been refined and so most of the water products we provide to irrigators are leases and they look like commercial property leases and that enables a farmer to gain access to the asset without using their balance sheet. Those leases look very much like commercial property. Leases tend to be terms of three to five years, cpi increases, all the standard stuff, but you don't have the challenges like you do on a commercial property, where the property could be impaired or burnt down or get rabbit infested or not maintained or the air conditioning unit, blow up or any of those things. It's a much simpler asset to manage in that way. So that works well. And we have a range of other products that enable irrigators to manage risk around the price that they pay for water, that enable irrigators to manage risk around the price that they pay for water. Things like forward contracts, where we'll guarantee a delivery of a particular volume at a particular time and a particular price. Products called carryover, where we provide a service so we can look after an irrigator's water in between one water season and the next for a fee.

Euan Friday, CIO, Kilter Rural: 32:14

Yeah, and look over the journey, we have developed a whole range of different water products, but it's sort of come down to you know, simplicity has its own real attraction and the products that we have in our portfolio at the moment seem to be really what meets the market. Our real objective is to team up with best practice farmers and be their partner to supply them with their limiting factor of production because that's what war is, you know on a long term basis. And yeah, so we have a really good portfolio of clients that were, you know, strong commercial relationships that have been built up over many years, that, yeah, that we just continue to work with and that enables them to get on with their business of, you know, of farming.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 33:03

And, as you say, it's capital efficient for them. They don't need to, you know, put it down all this money to go and buy the right so they can lease it from you effectively. So when you think about your return profile. So through the cycle, how much of it do you think is capital appreciation, how much of its rental yield, if you want to call it?

Euan Friday, CIO, Kilter Rural: 33:24

So we target a distribution after all, you know cost, fees etc. Four percent. Yeah, it's been a little challenging over the last few years where we've seen very low allocation prices and it's been more challenging to generate the lease yields we want, but we can see that that's now recovering. So we look to about a 4% yield and over the longer term about inflation plus 3% to 4% real growth. So that gives you around about the 6%. Over the last 15 years it's been higher than that, it's been more like 8%. But when we go out and we talk to investors we're looking to target returns in that 10% to 12% over a six, seven year investment horizon, 4% of that coming in income and the balance in growth and that's sort of reflective of what's been achieved historically.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 34:13

And when you're managing that book. So you're selling forward a component of your book and there'll be some of it that you're probably selling that spot. I'm assuming as well. What's the kind of ratio that you look?

Euan Friday, CIO, Kilter Rural: 34:26

Well, it depends a bit on where we are in the cycle. We would prefer to generate most of our income from leases and then have a balance of the book, say 30% or 40%, that we were generating income in the spot or forward market. We target 60% to 80% leases. We're a bit below that at the moment just because of where we are in the cycle. It's been harder because of the low allocation prices to write leases in the last couple of years at the yields we're targeting. But, as I say, we're starting to swing back the other way now and so we'd be lifting that percentage of the book that's leased out up towards our target 60% to 80%.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 35:08

Yeah, okay, and how long do those leases range for?

Euan Friday, CIO, Kilter Rural: 35:12

Three to five years generally. We have had longer term leases. The longest An equity anequity done have been 10 year leases and again they sort of look like a commercial property lease. Have a market review at year five and CPI, or index fixed index, increases during the term.

Damian Cilmi, Praemium Head of Investment Managers and Governance: 35:28

Yeah, and I suppose that gives investors a pretty good insight, like they could see a lease book as well and they can get a sense of the contractive flows.

Euan Friday, CIO, Kilter Rural: 35:41

That's exactly right. It looks exactly like a rate. Yeah, so we've got a while, we've got the, you know all that stuff.

Volume, weighted average, where lease a yield water rites all of those things are all the sort of stats that we talk to. 

Damian Cilmi, Praemium Head of Investment Managers and Governance: 35:55

You know our prospective investors where would this fit in their portfolio? You know we'll talk about correlations as well.

Euan Friday, CIO, Kilter Rural: 36:00

Well, yeah, I mean, that's the thing that we see investors love. It's very difficult to get true diversification, but in this asset class you've really got that diversification because it's driven by factors that are completely unlinked to the broader economic drivers that people are exposed to with virtually every other asset class they have. So, you know, when you look at the correlation of our water index back to things like, you know, an S&P 500 or the ASX 200 or gold, you know they're negative or negligible. It's just it doesn't exist, there isn't. And it makes sense because so much of the return profile has been driven by what the seasonal conditions have been over the last 16 years. That's driven the you know annual movements. Yeah, so it does provide true real diversification and, solid performance that it's underpinned by, really strong fundamental economic drivers.

Damian Cilmi Head of Investment Managers and Governance: 37:42

That's where water rights is really interesting. So we're so glad to bring you in and explain to our listeners all about this market. It's very, very interesting. Euan, thanks for joining us today.

Thanks, Damien.

Praemium Limited is the issuer of the Investment Leaders and Advice Leaders podcasts. These podcasts are for promotional purposes only and aren't tailored to individual financial situations and do not contain financial advice. Views expressed by presenters may not align with Praemium's. Thank you.